Metal Exchange Admits Oversight Problem

The London Metal Exchange’s chief executive admitted Wednesday that there are gaps in the regulatory procedures of the LME market, particularly its ability to scrutinize overseas nonmember firms such as Sumitomo Corp.

In an interview, David King refused to say whether the LME will change its rules on internal monitoring of large positions held by LME brokers or their clients, or whether the U.S. Commodity Futures Trading Commission is scrutinizing logbooks detailing the ownership of copper in the LME’s U.S. warehouses.

Sumitomo, Japan’s largest metal-trading firm, lost $1.8 billion allegedly as a result of unauthorized copper trades by its former chief trader, Yasuo Hamanaka. Copper prices have fallen 6% since the loss was announced last week.

“What we are talking about here is the unauthorized errant trading of an employee of a nonmember firm on the other side of the world over whom the exchange has no jurisdiction,” King said.

He said that “it was [as] a result primarily of our inquiries, which we shared with the regulatory authorities, that the situation was brought to a head.”

“Our first concerns were in 1991, when David Threlkeld provided information to me regarding documentation,” King said.

Threlkeld, a U.S. trader, sent a fax to King on Nov. 22, 1991, in which he said that Hamanaka had asked him in October to confirm to the Tokyo branch of British-based Winchester Commodities that certain nonexistent trades had taken place.

Threlkeld said Hamanaka told him the trades didn’t exist but that confirmation was needed for tax purposes.

King said he notified members of the documentation, raised the matter with Britain’s Securities and Investments Board and attended a meeting at the board’s offices with Hamanaka, other Sumitomo representatives and regulators.

“Subsequently . . . the director of Sumitomo publicly declared that the tax authorities were satisfied with the circumstances,” King said.

King said he notified Sumitomo in 1991 and 1993 that he was concerned about the size of its activities in the market and at the same time informed the securities board.

In October and November 1995, King said, he “became concerned about the structure of the market” and sought details, “including futures and options, long and short, of members and their clients, along with warrant holdings.”

“Since that time, the LME has worked very closely with the SIB,” the Securities and Futures Authority and the U.S. Commodity Futures Trading Commission, he said.

When asked why more stringent action wasn’t taken in 1991 or ‘93, King said: “Circumstances change; the situation last year was such that I was more concerned. There was also [in 1995] an issue of volatility between cash and three-months [prices], which wasn’t a phenomenon in previous years.”

On Wednesday, the Securities and Investments Board said it would review all British rules and practices involving metals trading over the next six months. Hamanaka’s worldwide trading practices are also being investigated.

King couldn’t say how the LME and SIB might change British regulations and LME rules specifically, though he said that “one of the issues is the jurisdictional regime regarding the exchange’s capacity to cover nonmembers.

“It is no different from the Barings situation,” he added, referring to the British investment bank that collapsed after the disclosure of nearly $1 billion in trading losses. The result of that was “that the regulatory authorities, both exchanges and authorities, met to identify how things might be changed,” he said.